Friday, February 24, 2012

Oil is rarely not political, and with gasoline prices hitting record levels early in a presidential election year, we shouldn't be surprised that both the President and his challengers have focused on energy policy. President Obama gave what was billed as a major speech on energy at the University of Miami in Florida yesterday. After urging more students to study engineering--a sentiment I would strongly second--he laid out his view of the situation and its solutions. He got a lot right, including the long-term nature of the problem and the value of improving the efficiency of our vehicle fleet. But unfortunately, he also missed the mark in many ways and generally reflected the exaggerated fatalism that his administration has consistently exhibited towards oil prices. Boosting domestic supply is not the only answer, but it could be far more effective in moderating high oil prices and their impact on the economy than the President admitted.

To see why requires a sense of how the oil market works, as well as the uses to which we put oil today, rather than a generation ago. For starters, although the President has worked hard to improve conditions for renewable energy sources like wind and solar power--sources that certainly have an important role to play in our long-term energy mix--these technologies, along with nuclear power, are out of place in a conversation about oil prices in 2012. That's because they produce electricity rather than liquid fuels, and less than 1% of US electricity is generated from oil today, compared to more than 10% in 1980. Electricity from renewable and nuclear power doesn't compete with imported oil or any other kind of oil; it competes with domestic energy sources like coal and natural gas, most of which now comes from conventional and unconventional gas fields, rather than as a byproduct of producing oil. So by all means lets have a conversation about renewables in the context of reducing greenhouse gas emissions today and displacing oil from transportation when there are tens of millions of electric vehicles on the road in the future, but in terms of oil prices now and in the near future, they are a rhetorical diversion.

Fuel efficiency and plain old conservation can play an important role in reducing both our exposure to higher oil prices and in contributing to lower prices, because both attack demand directly, and demand is a big factor in oil prices. The President is right to emphasize this. Americans have cut back on oil consumption to the tune of 1.8 million barrels per day since 2007, and this was a significant factor in the oil price collapse in late 2008 and the generally lower prices we've enjoyed since then. Unfortunately, that happened largely as a result of the recession and financial crisis, rather than a sudden spike in fuel efficiency. If Americans buy the new, more efficient cars that Detroit must make under the administration's stricter Corporate Average Fuel Economy standards, then over the next decades the efficiency of the US car fleet will improve significantly, and even after rebound effects our oil demand and need for imported oil should fall. But let's not delude ourselves that this can happen overnight. There are roughly 250 million cars, SUVs and light trucks on the road in the US today, and even at pre-recession sales levels it will take more than a decade to turn over enough of them to make a serious dent in oil consumption.

President Obama made only a passing reference to biofuels in his speech, and for good reason. At current production levels ethanol displaces up to 600,000 bbl/day of petroleum gasoline, after adjusting for its lower energy content. That's good, but we've essentially played that card already and can't play it again. Almost all the gasoline sold in the US today contains 10% ethanol, the maximum level that most cars can tolerate without damaging their fuel systems or voiding their warranties. There's little appetite among consumers for the 85% ethanol E85 blend that flexible fuel vehicles can use, and there's even less appetite among fuel distributors for the 15% ethanol blend that the EPA blessed in 2010. With ethanol maxed out for now, our focus must shift to biofuels that are much more compatible with gasoline and diesel fuel, and that rely on technologies that haven't yet been demonstrated at commercial scale or competitive cost.

And that brings us back to the potential for reducing our dependence on oil imports and moderating oil prices by producing more domestic oil. Now, it's certainly true that US oil production and consumption are only part of a much larger global oil market, where prices are actually set. The US couldn't control the global price of oil, as it once did, even if we imported virtually no oil from outside North America. However, it's simply not correct to gauge the potential impact of an extra million bbl/day of US production--a figure that is well within the range of what a more aggressive domestic drilling program could deliver--by comparing it to the entire global output of nearly 90 million bbl/day. As with other commodities like grain and coffee, the price of oil is determined by relatively small changes in supply, demand, inventories, and in the case of oil, spare capacity. What really counts is the last few million barrels per day that are traded, whether inventories are rising or falling, and how large global spare capacity is and who owns it. The last three times that oil prices collapsed, in the mid-1980s, late-1990s, and 2008, it happened as a result of net changes in these parameters amounting to less than about 3 million bbl/day.

Yesterday the President cited statistics indicating that US oil production has returned to levels we hadn't seen for several years. That's true, and it's equally true that this modest surge of about 14% is the result of factors over which his administration had no control: oil prices and federal policies in the previous administration and the application of improved drilling technologies in the deepwater Gulf of Mexico and onshore locations like North Dakota's Bakken formation and the Eagle Ford shale of Texas. Moreover, it's only technically accurate to state that he has "opened millions of acres for oil and gas exploration", when the lease sales in question were originally scheduled to have taken place earlier, and were to have encompassed much more acreage, including offshore acreage that has been off limits for decades, such as offshore Virginia. The Deepwater Horizon accident certainly changed the context for the President's previous drilling plans, but his administration's responsibility for the subsequent decline in offshore production, the slower pace of development and tighter geographic constraints on where the industry can look for oil since then must be acknowledged in this discussion.

Then there's that other shibboleth of oil prices, speculation, which was also mentioned yesterday. As I've discussed previously, there are times when speculation can increase some oil prices, at least for a brief period. However, it's worth recalling that for every trader buying futures contracts or options in hopes they will go even higher, some seller must take the position that current prices are high enough and likely to be lower, later. This adds a froth of sentiment to the market, but it can't sustain prices for long if fundamentals aren't supportive and if the physical market doesn't follow. So while politicians see a $10/bbl rise this month in the price of West Texas Intermediate on the futures market as a symptom of speculation, they tend to ignore data like the much larger recent increase in the spot price for Louisiana Light Sweet crude, for which someone must take physical delivery at St. James, Louisiana, rather than just offsetting against another "paper barrel". When you look at physical oil inventories, there's no evidence that speculators are taking delivery of large quantities of oil and storing it so refiners can't buy it.

The key factors driving the recent increase in oil prices are tensions with Iran and the fact that, with production off-line in places like Sudan and still not back to pre-revolution levels in Libya, OPEC's effective spare capacity is below 3 million bbl/day, not much above the level that contributed greatly to oil's near-$150 peak in mid-2008. So despite relatively weak demand growth, the market looks tight now, with the prospect of Iran cutting off sales--or being embargoed via sanctions from buyers--by a volume that would erode that cushion of spare capacity in Saudi Arabia and a few other Persian Gulf producers even further--capacity that mostly sits inside the Strait of Hormuz.

So what levers does this President--or any President--really have with which to try to moderate oil prices over the next few years? It's clearly not renewable energy policy at this point. It could include foreign policy, particularly if you agree with the view of Washington Post columnist David Ignatius that Iran has displayed a clear pattern of backing down in the face of "overwhelming force". Resolving the Iranian threat to Gulf shipping and setting the outlines of a solution to Iran's nuclear program could take $20/bbl off the price of oil in fairly short order, though I wouldn't suggest that looks easy. Yet even though a decision to expand access to US oil resources significantly, along the lines of the President's pre-Deepwater Horizon plan, would not deliver new production quickly, it's wrong to be dismissive about the impact of more drilling on prices or in mitigating the impact of those prices on the economy. And in the case of onshore opportunities for which infrastructure is already in place or in the works--and here I would include the Keystone XL pipeline--it need not take 10 years for the first barrels to reach market. Together with a strong, technology-neutral effort on fuel economy, a new, more expansive approach to exploiting domestic resources would affect the back end of the futures price curve, and that could start to nudge down nearer-term prices, as well. Even if I'm wrong about that, it's still the case that at current prices every additional 1,000 bbl/day we produce here would reduce our trade deficit and the drag on our economy by about $40 million--and there are a lot more thousands of barrels per day we could be producing.

At least one of the President's potential challengers has described a plan for getting gas prices back to $2.50 per gallon. Perhaps this had something to do with President Obama's choice of topic yesterday. I will devote a lot more time to analyzing such proposals once the Republicans have chosen their nominee. However, it's worth noting that as outlandish as $2.50/gal. sounds when the average price of unleaded regular has jumped to $3.59/gal. this week, it works out to an effective crude price of around $70/bbl, after subtracting state and federal taxes and refiner and dealer margins. That's roughly what oil cost in 2006 and 2007 and more than in 2009. It's also a higher price than most oil industry experts even imagined would be possible just a few years earlier.

I don't know if Mr. Gingrich's plan would work, and I suspect that the economics of at least some of the new production necessary to force OPEC to compete on price again, rather than managing the price to suit their own needs, might be challenging at $70/bbl. Yet I'd be much more inclined for us to work towards such a goal than to dismiss it as impossible or irrelevant and fatalistically accept the consequences of $100+ oil for another decade or more. The President should at least be as open to these possibilities as he is to the possibilities of renewable energy for reducing emissions.

Wednesday, February 22, 2012

The Obama administration is proposing significant changes in US corporate taxes, as reported in today's Wall St. Journal. If enacted, the corporate tax rate would fall from 35% of income to 28%, although the elimination of numerous tax incentives would subject many companies, including most in the energy sector, to higher taxes overall. On the surface, this looks like the kind of tax reform that has been long overdue; however, as always with such efforts, the details matter enormously. In this case, the details would create an even less-level playing field for US energy producers, while doubling down on the expensive tax benefits currently provided to favored sectors and technologies. It's ironic that this is being proposed just when rising gasoline prices have put the administration on the defensive concerning its energy policies. It will do the President little good to point to increasing US oil production--demonstrably the result of energy prices and policies in previous administrations--if he simultaneously jeopardizes that recovery in output by making it less attractive to produce oil and gas here.

The basic principle of cutting marginal corporate tax rates in exchange for the elimination of "tax expenditures", or loopholes, in common parlance, is consistent with the much broader tax reform proposed by the fiscal commission established by the White House in 2010, even if the administration has opted for the upper end of the range of tax rates suggested by Simpson-Bowles. In general, US oil and gas companies wouldn't be worse off for losing the various deductions and tax credits in the current tax code, if the marginal tax rate were reduced sufficiently and if the administration weren't proposing to raise royalty rates on US onshore production by 50% at the same time. However, the combination of the proposed changes, including subjecting part of their non-US income to US taxation, would not only make US oil and gas projects less attractive, relative to projects in other countries; they would also make it less attractive to be a US oil and gas company, instead of a non-US company that operates here. For an administration that is concerned about US competitiveness, this is perverse logic, indeed.

It doesn't take a crystal ball to predict that the combination of higher corporate taxes on energy companies, higher royalties, and the more complex permitting processes instituted by the administration even before the Deepwater Horizon accident will make it much harder to sustain the recent recovery in US oil output beyond the completion of projects that were initiated during the previous administration. New oil and gas production would probably still be profitable here after these changes, particularly if oil prices remain as high as they are now, but company portfolios would begin to shift back towards non-US projects that look more rewarding by comparison, and US companies would lose some of their edge to non-US competitors. None of that would be good for US energy consumers, considering that the oil and gas industry accounts for 62% of the energy we use, including 49% of all energy produced domestically.

Of course, the administration's tax proposals reach well beyond oil and gas. Among other things, they would extend the Production Tax Credit for wind energy by another year, through 2013, as well as extending for another year the Treasury renewable energy cash grants that expired at the end of last year. After 2012, the cash grants would be replaced by refundable tax credits, which essentially means you'd get a check from the IRS, rather than from the Treasury, if the credit were larger than the taxes your firm owes. The net effect of the latter would perpetuate a costly system of renewable energy subsidies that reward the deployment of renewable energy hardware, rather than the actual generation of renewable energy. (That distinction is important whenever the hardware is installed somewhere lacking in good wind, sun, or other renewable resources.)

Then there's the proposal to boost the electric vehicle tax credit to a maximum of $10,000 per car, and to shift the recipient from the purchaser to the seller. That circumvents the problem that under the current $7,500 credit you'd have to earn enough income to be paying at least that much in federal income taxes, in order to enjoy the full benefit of the credit. However, it also makes it much likelier that manufacturers and dealers would pocket a significant slice of the higher credit, instead of consumers. Since it was nearly impossible to justify the $7,500 per car credit on the basis of actual oil or emissions savings, the higher credit looks even less justifiable, other than as a means of raising the odds of achieving the President's arbitrary target of putting a million EVs on the road by 2015--another near impossibility. The pluses I see here include an automatic phaseout based on time, rather than sales volume, and a broadening of the credit to cover other efficient vehicle technologies such as natural gas, though it's not clear whether it would also cover advanced diesels. Still, if the President has his way, we'll be spending more than $10 billion to put vehicles on the road that will save less than 35,000 barrels per day of oil, or about 0.4% of our total gasoline consumption, along with greenhouse gas emissions worth less than $1 billion at market prices--even European market prices.

The proposals include other provisions that would affect the energy sector, including tax benefits for advanced energy manufacturing such as wind turbines, solar panels, advanced batteries, electric vehicles, and an array of other equipment. I'd be much happier with those incentives if they were provided as an alternative to origin-blind deployment incentives, instead of alongside them. And although oil and gas companies would lose the manufacturing tax deduction on their US production, it appears they might get to keep that deduction on US refining, which has been hurt by higher oil prices. That would be small consolation to independent refining companies that have been forced to close several large east coast refineries or that are barely breaking even.

If President Obama is serious about tax reform, the current proposals--flawed as they are--would have carried a lot more weight had they been introduced a year ago, in the immediate aftermath of the Simpson-Bowles report and various other tax reform suggestions, rather than in an election year. And if he is truly serious about the"all-out, all-of-the-above strategy" for energy that he referenced in this year's State of the Union address, the current proposals look like an extremely odd way to execute that, favoring as heavily as they do sources that account for less than 2% of US energy production, while penalizing those that contribute nearly half. The good news is that this is a meal that won't be eaten hot. For now, this package serves as another plank in the reelection campaign platform. Whether it will ultimately be implemented depends not just on who occupies the White House after January 20, 2013, but also on the composition of the next Congress since it has no chance of passage in the 112th.

Wednesday, February 15, 2012

An editorial in today's New York Times praising the energy priorities included in the President's latest budget is little more than a rubber stamp of a set of policies in serious need of rethinking. The goals the Times espouses, of "reducing America’s dependence on foreign oil and giving American workers a fighting chance in the global competition for clean-energy jobs", are perfectly fine; however, what's entirely absent is any critical assessment of whether the expensive programs they chose to highlight will contribute meaningfully to accomplishing them.

Start with the reauthorization of Treasury cash grants for renewable energy projects. A quick review of the Treasury's own tracking spreadsheet shows that 77% of the $10.4 billion awarded since 2009 under this program went to projects employing wind turbines, a mostly mature technology, half the value of which goes to offshore manufacturers, based on the American Wind Energy Association's own assessment. If the goal is putting Americans to work producing wind power hardware, this is a grossly inefficient way to do it. Moreover, this temporary program was instituted to fill the gap created when the market for "tax equity"--private transactions that exchange current cash for future tax credits--dried up during the financial crisis. Tax equity investors have recently been returning to the market, but they can't readily compete with free money from the Treasury Department. In other words, at this late date the Treasury cash grants are a solution to a problem that their continuation would help perpetuate.

Then there's the matter of the wind production tax credit, which I looked at in some detail recently. While I agree that it's neither fair nor appropriate to drop the industry off a cliff by allowing this benefit to expire all at once, it is high time that the 20-year-old tax credit for wind power be reduced to account for the maturity of onshore wind technology, and then gradually phased out on a firm schedule. The Times makes no mention of any of this.

It's also important to understand that whatever the technologies covered by these two programs may contribute to reducing greenhouse gas emissions, they don't save a barrel of imported oil, because the US generates less than 1% of our electricity from oil, and much of that in island or other remote locations that can't easily get reliable electricity through other means. That makes it doubly ironic that the only "subsidies" the Times opposes are the current tax benefits for oil and gas companies, arguably the only program mentioned in their editorial that actually does help reduce US imports of foreign oil.

The President's 2013 budget, which has little chance of adoption as proposed, includes a number of other energy provisions. Some of them are very worthy, including increased support for energy R&D that is too risky or long-term for industry to undertake on its own. However, it also includes an extension of the loan guarantee program that gave us Solyndra--a program that should not be renewed without much stronger oversight than the DOE has provided to date, beyond just hiring a "chief risk officer". It also mentions "enhancements to the existing electric vehicle tax incentive", a $7,500 per vehicle credit that benefits mostly higher-income taxpayers and does little to reduce either emissions or oil imports. What I don't see in these proposals is any recognition that many of the programs they seek to extend or expand have either outlived their usefulness or fallen short of delivering the benefits on which they were originally justified, and that every dollar spent inefficiently in this manner adds to our $1.3 trillion deficit, the necessary narrowing of which keeps getting pushed ever further into the future. The administration's latest energy priorities would have us spending as though it were still 2006.

Monday, February 13, 2012

I was only partially surprised to read in MIT's Technology Review that Amyris, a biotechnology company developing renewable diesel and jet fuel from sugar cane, was backing away from the biofuel market to pursue more lucrative products. Fuels are a highly competitive, low-margin business, and it's hard enough to make money refining them even with established technology and a ubiquitous feedstock like crude oil. This is a great, under-appreciated challenge facing every company that seeks to produce new, greener fuels from biomass using processes that haven't yet reached commercial scale or are only just arriving there. The key is either to produce something for which customers will pay better-than-commodity prices, yielding a high margin per gallon, or on such a vast scale that you can survive with a thin margin.

When I listened to the replay of the investor call Amyris held last week, I picked up some nuances missing from the Technology Review article. Confining its biofuels efforts to joint ventures with Total and with Cosan, a large Brazilian sugar and ethanol producer, probably makes sense for Amyris for many reasons. However, the discussion of value vs. volume segmentation on the call pointed to the need to attain a scale in fuels that would likely be beyond the wherewithal of a firm its size, investing on its own. As it is, the total cane ethanol production of its Brazilian partner Cosan--via the latter's JV with Shell--is still less than the throughput of all but a handful of US oil refineries, and only about one-tenth the volume by which Shell's Motiva joint venture is expanding its Port Arthur, TX refinery. Biofuel refineries needn't reach that scale--they probably couldn't due to the limitations of their feedstock logistics, in any case--but they still need to crack the challenge of repaying big capacity investments while making low-margin products, in addition to any technical challenges they face.

Last week I ran cross a clever plan to circumvent this challenge, in conjunction with meeting the 36 billion gallon per year US Renewable Fuel Standard (RFS). Jim Lane of Biofuels Digest proposed a scenario for meeting the 2022 RFS target using mainly existing corn ethanol and biodiesel facilities. He suggests converting the former to produce higher-value biobutanol, and then capturing and converting their CO2 emissions--after correcting a typo that pegs them at 90 million lb. per year instead of 90 billion lb.--into additional fuels using algae or solar energy. Mr. Lane gets full marks for ingenuity and for coming up with a pathway that doesn't depend on the widespread adoption of E15 and E85 ethanol blends that the public hasn't embraced and might never. However, in my view it relies too much on promising but unproven technologies and on the durability of a price premium for butanol in chemical markets that would be completely swamped by fuels-scale output. I'd expect any shift from ethanol to butanol to proceed only about as far as it took to crush the price differential between butanol and wholesale gasoline.

The advance biofuels industry has made enormous strides in the last decade and proved that you can start with biomass or even CO2 and produce fuels that are chemically identical or otherwise broadly compatible with the petroleum-based fuels that remain the world's primary source of energy for transportation. What it hasn't yet achieved is to prove that it can do so at a cost that competes with that of oil, even when the latter is over $100 per barrel, notwithstanding the cumulative trillions of cubic feet of rhetoric asserting that it can do so as soon as it scales up. The experience of companies like Amyris, which is refocusing its wholly-owned activities on high-margin speciality products, rather than fuel, and of cellulosic dropouts like Range Fuels, reminds us just how hard this will be.

Thursday, February 09, 2012

US gasoline prices are setting records for this time of the year, with the current price apparently the highest ever for February, at least in nominal dollars. In fact, the monthly average US retail price for unleaded regular has set new records every month since last October. That isn't quite as dramatic as it might seem, because based on the Department of Energy's data, the previous records for those months were set just a year earlier. Yet it's still a significant drag on the economy--an anti-stimulus, as I've noted previously. Unfortunately, some of the explanations I've seen for these price levels, including the ones offered in last night's CBS Evening News, focus too much on minor factors such as refinery maintenance and commodity speculation, while ignoring the most basic influence: the price of oil. That's understandable if they're watching the wrong oil price.

If you've been reading this blog for a while, you know why the most-watched oil price in America, the one for West Texas Intermediate crude (WTI), is no longer representative of the broader US oil market, at least for now. The best domestic grade to follow at the moment is probably Louisiana Light Sweet (LLS), which is of similar quality to WTI but not subject to the persistent transportation bottleneck at Cushing, OK. It tracks closely to UK Brent crude, which has largely taken over the role of global oil price indicator. The "spot" price of LLS was $119 per barrel today, accounting for 94% of the price of prompt gasoline futures on the New York Mercantile Exchange (NYMEX) today. And the $16/bbl increase in LLS since February 9, 2011 explains nearly 80% of the increase in the wholesale gasoline price over that interval. So while refinery outages might be having some impact, particularly in the local and regional markets served by the affected facilities, they are not the main show, nor is speculation in gasoline futures, the effect of which beyond the New York area covered by the NYMEX contract should be rather attenuated.

So with gas prices this high, this early in the year, how high might they be when the summer driving season arrives? That also comes down to crude oil, prompting questions about why oil prices are so high today, despite relatively weak demand. Many analysts attribute oil's strength to worries about Iran's threat to close the Strait of Hormuz as the sanctions noose tightens, along with rumors that Israel may be preparing to strike Iran's nuclear sites on its own this spring. But as with any such risks, they will either manifest or they won't, and the more time that goes by without these feared events occurring, the less influence they are likely to have in propping up oil markets, absent a surge in underlying demand due to a strengthening global economy. If none of that takes place, then oil prices could ease, resulting in summer gas prices not much worse than what we see today. However, I'd be wary of reversing that logic: Keeping gas prices low is not a sufficient reason to back away from addressing the risks posed by what the International Atomic Energy Agency refers to as the "military dimensions" of Iran's nuclear program.

Tuesday, February 07, 2012

I just ran across British Columbia's new provincial natural gas strategy, which includes a specific strategy for expanding liquefied natural gas (LNG) production as a way to mitigate global climate change. That might sound odd to those who are worried--unnecessarily--that gas might be even worse than coal, emissions-wise, but the province seems to have a good grasp of the benefits of replacing coal combustion in Asia with cleaner fuels like natural gas. They've also come up with a unique selling point for their LNG, on the basis that it would be produced using low-emissions electricity and thus have an emissions edge over other LNG sources. Whether this will confer an advantage on B.C.'s LNG by enabling it to collect a premium or capture a larger share of rapidly growing global LNG trade remains to be seen.

This story caught my eye because it fit neatly with one theme of a webinar in which I recently participated at The Energy Collective. Although most greenhouse gas emissions from fossil fuels occur at the point of combustion in a car, truck, plane, train, ship or power plant, the upstream emissions aren't insignificant and can be reduced in some cases by employing renewable energy in their production. Examples I cited in the webinar included an enhanced oil recovery demonstration project in California that employs concentrated solar power to produce some of the steam used to extract oil from an old oil field, and another project to extract geothermal energy from hot fluids brought to the surface as part of the oil production process.

The case that B.C. makes for reducing greenhouse gas emissions from LNG production by relying on the province's bountiful hydro- and wind power resources is a different application of the same principles. That's because whether the energy for cooling billions of cubic feet per day of natural gas to its liquefaction temperature of -162ºC comes from a local electricity grid or from burning some of the gas in a dedicated cogeneration facility, in most locations this adds significantly to the lifecycle emissions of the LNG. One study that I found on the California Energy Commission's site, produced by PACE Consultants, indicates that liquefaction accounts for around 10% of the lifecycle emissions of LNG converted to electricity in an efficient gas turbine power plant. Eliminating those extra emissions by powering a liquefaction plant with green electricity would bring the emissions from LNG much closer to those from pipeline natural gas and increase its advantage versus coal.

So now what B.C.'s LNG projects need is customers in Asia who will put a premium on "cleaner LNG"--presumably in countries that have committed to large greenhouse gas emission cuts that they can't achieve with indigenous fuels. Japan comes to mind, but I'm sure there are others. These customers would also have to be willing to deal with the longer voyage times from Kitimat, northern B.C. to Asia, compared to competing projects in Australia. That extra 1,000 miles or so translates into higher freight costs and a larger tanker fleet, along with somewhat higher emissions from transportation--though not enough to negate the liquefaction advantage. With so many new and expanding LNG projects around the world competing for market share, I'll be very interested to see whether B.C.'s new strategy pays off.

Thursday, February 02, 2012

In observing the recent struggles of various segments of the global cleantech industry, including renewable energy and advanced energy technology firms, a pattern is emerging. Today's Wall St. Journal reports "Wind Power Firms on Edge," as the US wind industry hunkers down pending the renewal or expiration of a key subsidy at the end of 2012. A maker of electric-vehicle batteries that received a federal grant to build a factory in Indiana is reorganizing via bankruptcy, wiping out the equity of its original investors. Meanwhile, the US International Trade Commission may be on the verge of imposing retroactive tariffs on imported Chinese solar power equipment. Each of these stories has unique features, but what they share in common is the consequences of renewable energy policies around the world that promoted overcapacity in manufacturing and fierce competition in deployment, effectively setting up some of their past beneficiaries for failure or at least a period of very low margins. Depending on your perspective, this is either an indictment of such subsidies or collateral damage on our way to a brighter future.

One blogger from an advanced battery trade association noted that "Ener1 Is No Solyndra", and I tend to agree. As I've noted previously, the decision to award Solyndra a $535 million federal loan was ill-advised, not just because of competition from other solar manufacturers, but because at the time the government approved the loan the failure of Solyndra's business model was essentially already predetermined. Solyndra didn't contribute much to the global overcapacity in solar modules and panels, because its technology was never competitive. By contrast, Ener1's problems appear more fundamental. Like much of the global wind industry and solar industry, it was induced to invest in new capacity, the market for which depended almost entirely on subsidies and regulations that governments might not be able to sustain as these technologies scaled up, and that has gotten significantly ahead of demand.

The best examples of that are probably the various solar feed-in tariff (FIT) subsidies in Europe, which until recently were so generous that they not only supported the intended growth of an indigenous solar industry to capitalize on them, but also gave rise to an entirely unintended new export-oriented solar industry in Asia that had essentially no local market when it started, yet has since gone on to dominate global solar manufacturing and eat the lunch of the European solar makers and developers who got fat off the earlier stages of the FITs.

Or consider the US wind industry, including the imported equipment that still supplies around half of the US wind turbine value chain, according to the main US wind trade association. If the 2.2¢ per kilowatt-hour (kWh) Production Tax Credit (PTC) is renewed, and if wind generation grows from the current level of 115 billion kWh per year to 141 billion kWh by 2021, in line with the latest Department of Energy forecast, then over the next 10 years the wind industry would collect up to $30 B, with much of that locked in for projects that have already started up, less the amount generated by projects that opted for the expired Treasury cash grants in lieu of the PTC to the tune of $7.9 B from 2009-11. Yet based on these figures, wind would supply just 3.2% of US electricity in 2021. The industry now seems to be arguing that it needs just one more renewal of the PTC in order to become competitive. As of 2012, this benefit has been in place on an on-again, off-again basis for twenty years.

Although the theory that underpins such subsidies doubtless has some validity--that governments can help new technologies to develop quicker than markets alone would support, create markets for them by stimulating demand, and thereby move them down their learning curves to earlier competitiveness with conventional technologies--in practice such policies also have the serious shortcomings we are seeing. Because they do not operate in Soviet-style centrally planned economies, none of these governments can tell manufacturers precisely how much production capacity to build, or how much they will sell when it comes on-stream. In the absence of such powers--which in any case proved to be over-rated--companies and their investors are at the mercy of the boom-and-bust cycles such policies generate, with the normal, self-correcting mechanisms of industry consolidation dampened by continued intervention. Nor do the policies now in place seem very successful at creating industries that can survive without them. If you doubt that, ask the US wind industry for their forecast of new installations next year if the two-decade-old PTC is not renewed. According to the Journal, it would be somewhere between 0% and 30% of 2011's 6,810 MW, which was itself a third below the 2009 peak of 10,000 MW, despite the late-2010 extension of the cash grants to cover last year's projects.

The appropriate response to all of this depends on one's politics and the firmness of one's belief that these technologies are essential tools for combating climate change. Falling between the extremes of "just say no" and "look the other way" is the view that governments at least have an obligation to learn from the past and avoid the temptation to yield to demands that they leave existing subsidies in place until their beneficiaries decide they are done with them. If wind tax credits are extended, it should be at a level that recognizes the narrowing competitive gap with conventional energy and phases them out on a schedule. Electric vehicle subsidies should also be reassessed so that we don't find ourselves still providing upper-income taxpayers with incentives of $7,500 per car, even after sales have taken off and sticker prices fallen significantly. And solar subsidies ought to be fundamentally rethought to make it less attractive to install solar panels in regions with low sunlight, such as New York and New Jersey, than in those with abundant sun. And we shouldn't do that just for the benefit of taxpayers and in response to trillion-dollar budget deficits, but in the interest of producing healthy, globally competitive companies in these industries.